I have the explanation to the question below, but I need help understanding some
ID: 2761994 • Letter: I
Question
I have the explanation to the question below, but I need help understanding some of the terms Such as
What does D3 =
What does g3=
Also what is the meaning of Total CFs and how do I get the answers $2.275 and $68.193?
Same goes for PV of CFs, how do I get $2.087 and $57.397?
In regards to the stock price how do they arrive to $59.48 (Answer c) ?
Thanks for the help.
Nachman Industries just paid a dividend of D0= $1.75 Analysts expect the company's dividend to grow by 30% this year, by 10% in Year 2, and at a constant rate of 5% in Year 3 and thereafter. The required return on this low- risk stock is 9.00%. What is the best estimate of the stock’s current market value?
a.$55.91
b.$48.18
c.$59.48 (Answer)
d.$72.57
e.$50.56
Answer: c
Explanation:
rs= 9.0%
Year 0 1 2 3
Growth rates: 30.0% 10.0% 5.0%
Dividend $1.75 $2.275 $2.503 $2.628
Horizon value = D3/(rs-g3) = 65.691
Total CFs $2.275 $68.193
PV of CFs $2.087 $57.397
Explanation / Answer
Calculate the dividend value for 1 to 3 years:
Year
Dividend
Indicate
Growth rates
Growth
Indicate
Dividend
0
D0
-
g0
$ 1.75
1
D1
30%
g1
$ 2.28
2
D2
10%
g2
$ 2.50
3
D3
5%
g3
$ 2.63
Where D3 is dividend year 3 and g3 indicates that growth for year 3.
Terminal value / (horizon value) = D3 / (rs – g3)
= $2.63 / (0.09 -0.05)
=$65.691
Total cash flows (CF) = $65.691 add to second year divided is $2.503 i.e., $68.193
Present value of cash flows (PV CFs) = [$2.503 * (1/1.09)] = $2.087
= [$68.193 * (1/1.092) ] = $57.397
Year
Dividend
Indicate
Growth rates
Growth
Indicate
Dividend
0
D0
-
g0
$ 1.75
1
D1
30%
g1
$ 2.28
2
D2
10%
g2
$ 2.50
3
D3
5%
g3
$ 2.63